Definitions

target company

Conglomerate (company)

A conglomerate is a large company that consists of seemingly unrelated business sections. The term may also refer to a multi-industry company.

History

The Dutch East India Company can be considered to be one of the earliest conglomerate groups; originally a trade enterprise established to ship goods from the Far East to the Dutch Republic, the East India Company grew into a powerful economic entity embracing economic ventures focused on commerce and manufacturing.

The end of the First World War caused a brief economic crisis in Weimar Germany, permitting entrepreneurs to buy up varied businesses at rock-bottom prices. The most successful, Hugo Stinnes, established the most powerful private economic conglomerate in 1920s Europe - Stinnes Enterprises - which embraced sectors as diverse as manufacturing, mining, shipbuilding, hotels, newspapers, and an assortment of other economic enterprises.

Conglomerates were popular in the 1960s due to a combination of low interest rate(s) and a repeating bear/bull market, which allowed the conglomerates to buy companies in leveraged buyouts, sometimes at temporarily deflated values. Famous examples of the 1960s conglomerators include Ling-Temco-Vought, ITT Corporation, Litton Industries, Textron, Teledyne, and Gulf and Western Industries. As long as the target company had profits greater than the interest on the loans, the overall return on investment (ROI) of the conglomerate appeared to grow.

For many years this was enough to make the company's stock price rise, as companies were often valued largely on their ROI. The aggressive nature of the conglomerators themselves was enough to make many investors, who saw a "powerful" and seemingly unstoppable force in business, buy their stock. High stock prices allowed them to raise more loans, based on the value of their stock, and thereby buy even more companies. This led to a chain reaction, which allowed them to grow very rapidly.

However, all of this growth was somewhat illusory. As soon as interest rates started to rise in order to offset inflation, the profits of the conglomerates fell. Investors also noticed that the companies inside the conglomerate were growing no faster than they had before they were purchased, whereas the rationale for buying a company was often that "synergies" would lead to more efficiency. By the late 1960s they were frowned on by the market, and a major sell off of their shares ensued. In order to keep the companies going, many conglomerates were forced to shed the industries they had purchased recently, and by the mid-1970s most had been reduced to shells. The conglomerate fad was subsequently replaced by newer ideas like focusing on a company's core competency.

Cash flush during the 1980s, General Electric also moved into financing and financial services, which in 2005 accounted for about 45% of the company's net earnings. GE also owns a majority of NBC Universal, which owns a major American television network. In some ways GE is the opposite of the "typical" 1960s conglomerate: the company was not highly leveraged, and when interest rates went up they were able to turn this to their advantage as it was often less expensive to lease from GE than buy new equipment using loans. United Technologies has also proven to be an extremely successful example of a conglomerate.

Another example of a successful conglomerate is Berkshire Hathaway, which used its insurance surplus to invest in a variety of manufacturing and service businesses.

The best known British conglomerate was Hanson plc. It followed a rather different timescale than the U.S. examples mentioned above, as it was founded in 1964 and ceased to be a conglomerate when it split itself into four separate listed companies between 1995 and 1997.

In Japan, a different model of conglomerate, the keiretsu, envolved. Whereas the Western model of conglomerate consists of a single corporation with multiple subsidiaries controlled by that corporation, the companies in a keiretsu are linked by interlocking shareholdings and a central role of a bank. Mitsubishi is one of Japan's best known keiretsu, reaching from automobile manufacturing to the production of electronics such as televisions.

In South Korea, Chaebol is a type of conglomerate owned and operated by a family. Chaebol is also inheritable as most of current presidents of Chaebol succeeded their fathers or grandfathers. Some of the well-known Korean Chaebols are Samsung, LG and Hyundai Kia Automotive Group.

The era of Licence Raj (1947-1990) in India created some of Asia's largest conglomerates such as the Tata Group, Kirloskar Group, Reliance Industries and the Aditya Birla Group.

Potential advantages

To modern business analysts, the best argument for conglomerate organizational form is that it may allow capital to be allocated in a more efficient way. For example, a hypothetical conglomerate consists of a candy store and an internet website. Suppose the candy store has high cash flow, but very few profitable investment opportunities. The website has low cash flow, but lots of good investment projects. By combining the businesses together, the cash from the candy store can be used to make profitable investments that would otherwise not be made in the web site. The main question associated with this strategy is why this improves upon a market-based allocation of capital. That is, if the entities were standalone, then presumably the investors in the candy store could receive dividends, and then reinvest those dividends in the startup. If this market-based mechanism works well, then all profitable internet startup investments can be made without having the two entities be under common ownership. Research suggests that financial markets may not always operate efficiently due to the presence of transaction costs and asymmetric information. If this problem is severe, then the common ownership of the assets might yield a more efficient allocation of capital.

Potential disadvantages

Lack of focus and inability to manage unrelated businesses equally well are the reasons to criticize conglomerates. As a result, conglomerates' stocks are usually penalized by the market. This phenomenon is called conglomerate discount.

Media conglomerates


In her 1999 book No Logo, Naomi Klein provides several examples of mergers and acquisitions between media companies designed to create conglomerates for the purposes of creating synergies between them:

  • Time Warner (now merged with AOL) have a series of tenuously linked business including internet access, internet content provision and music, film and traditional publishing. Their diverse portfolio of assets allow cross-promotion and economies of scale. (However, Time Warner has since divested its music and book publishing interests, and there is growing pressure to spin off its Time Warner Cable and AOL units.)
  • Clear Channel Communications, a quoted company, at one point owned a variety of TV and radio stations, together with a large number of concert venues, across the U.S. and a diverse portfolio of assets in the UK and other countries around the world. The concentration of bargaining power in this one entity allowed it to gain better deals for all of its business units. For example, the promise of playlisting (allegedly, sometimes, coupled with the threat of blacklisting) on its radio stations was used to secure better deals from artists performing in events organized by the entertainment division. These policies have been attacked as unfair and even monopolistic, but are a clear advantage of the conglomerate strategy. On December 21, 2005, Clear Channel completed the spin-off of Live Nation. Live Nation owns the events and concert venues previously owned by Clear Channel Communications.

See also

References

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